1
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[ X ] SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
______________________
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
[ ] SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ___________________
Commission file number 0-13801
_______
QUALITY SYSTEMS, INC.
_________________________________________________________________
(Exact name of registrant as specified in its charter)
California 95-2888568
_______________________________ ___________________
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
17822 East 17th Street, Tustin, California 92780
__________________________________________ __________
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (714) 731-7171
______________
NOT APPLICABLE
________________________________________________________________
(Former name, former address and former fiscal year, if changed,
since last year)
Indicate by check mark whether the issuer (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to
such filing requirements for the past 90 days.
Yes XX No
---- ----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
5,974,412 shares of Common Stock, $.01 par value,
as of August 8, 1997
2
PART I. CONSOLIDATED FINANCIAL INFORMATION
------- ----------------------------------
Item 1. Financial Statements
------- --------------------
QUALITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, March 31,
ASSETS 1997 1997
----------- -----------
Current Assets:
Cash and cash equivalents $15,858,000 $21,852,000
Short-term investments 910,000 883,000
Accounts receivable, net 8,063,000 6,574,000
Inventories 1,062,000 1,071,000
Other current assets 654,000 628,000
----------- -----------
Total current assets 26,547,000 31,008,000
Equipment and Improvements, net 1,698,000 1,391,000
Capitalized Software Costs, net 1,216,000 1,041,000
Excess of Cost Over Net Assets of Acquired
Business, net 2,789,000 2,868,000
Deferred Tax Asset 1,925,000 -
Other Assets, net 2,240,000 1,558,000
----------- -----------
Total assets $36,415,000 $37,866,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 1,500,000 $ 1,345,000
Deferred service revenue 1,612,000 1,493,000
Estimated costs to complete
system installations 522,000 565,000
Other current liabilities 3,042,000 1,992,000
----------- -----------
Total current liabilities 6,676,000 5,395,000
Deferred Tax Liability 232,000 201,000
----------- -----------
Total liabilities 6,908,000 5,596,000
----------- -----------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $0.01 par value, 20,000,000
shares authorized, 5,993,712 and 5,997,462
shares issued and outstanding, respectively 60,000 60,000
Additional paid-in capital 34,116,000 34,144,000
Accumulated deficit (4,669,000) (1,934,000)
----------- -----------
Total shareholders' equity 29,507,000 32,270,000
----------- -----------
Total liabilities and shareholders' equity $36,415,000 $37,866,000
=========== ===========
See notes to consolidated financial statements.
3
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
June 30,
------------------------
1997 1996
----------- -----------
Net Revenues:
Sales of computer systems,
upgrades and supplies $ 4,710,000 $ 2,829,000
Maintenance and other services 2,463,000 1,926,000
----------- -----------
7,173,000 4,755,000
Cost of Products and Services 3,567,000 2,324,000
----------- -----------
Gross Profit 3,606,000 2,431,000
Selling, General and
Administrative Expenses 2,537,000 1,438,000
Research and Development Costs 828,000 457,000
Purchased In-Process Research and
Development 4,720,000 8,300,000
----------- -----------
Loss from Operations (4,479,000) (7,764,000)
Investment Income 276,000 386,000
Equity in Loss of Clinitec
International, Inc. - (31,000)
----------- -----------
Loss before Provision for
(Benefit from) Income Taxes (4,203,000) (7,409,000)
Provision for (Benefit from)
Income Taxes (1,468,000) 358,000
----------- -----------
Net Loss $(2,735,000) $(7,767,000)
=========== ===========
Net Loss per Share $(0.46) $(1.34)
=========== ===========
Weighted Average Number of
Shares Outstanding 5,998,000 5,807,000
=========== ===========
See notes to consolidated financial statements.
4
QUALITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended June 30,
---------------------------
1997 1996
------------ -------------
Cash Flows from Operating Activities:
Net loss $(2,735,000) $(7,767,000)
Adjustments to reconcile net
loss to net cash provided by (used in)
operating activities:
Purchased in-process research and
development 4,720,000 8,300,000
Depreciation and amortization 396,000 206,000
Gains on short-term investments (27,000) (36,000)
Equity in loss of Clinitec
International, Inc. - 31,000
Deferred income taxes (1,771,000) 98,000
Changes, net of amounts acquired, in:
Accounts receivable (1,292,000) (678,000)
Inventories 9,000 197,000
Other current assets (117,000) 90,000
Other assets (53,000) -
Accounts payable 101,000 (630,000)
Deferred service revenue (42,000) 90,000
Estimated costs to complete
system installations (43,000) 27,000
Income taxes payable and taxes
related to equity accounts 119,000 171,000
Other current liabilities 469,000 (10,000)
------------ -----------
Net Cash Provided by (Used in)
Operating Activities (266,000) 89,000
------------ -----------
Cash Flows from Investing Activities:
Proceeds from sales of
short-term investments - 38,000
Purchases of short-term investments - (55,000)
Net additions to equipment
and improvements (341,000) (129,000)
Additions to capitalized
software costs (300,000) (49,000)
Purchase of Additional Ownership
Interest in Clinitec
International, Inc. - (4,946,000)
Purchase of Net Assets of MicroMed
Healthcare Information Systems, Inc. (5,259,000) -
Change in other assets 200,000 (17,000)
------------ -----------
Net Cash Used in Investing Activities (5,700,000) (5,158,000)
------------ -----------
Cash Flows from Financing Activities:
Purchase of Common Stock $ (34,000) $ -
Proceeds from Exercise of
Stock Options 6,000 -
------------ -----------
Net Cash Used in Financing Activities (28,000) -
------------ -----------
Net Decrease in Cash and Cash Equivalents (5,994,000) (5,069,000)
Cash and Cash Equivalents,
beginning of period 21,852,000 27,872,000
----------- -----------
Cash and Cash Equivalents, end of period $15,858,000 $22,803,000
=========== ===========
Supplemental Information - During the three months ended June 30, 1997 and
1996, the Company made net income tax payments of $186,000 and $34,000,
respectively.
Three Months Ended June 30,
---------------------------
1997 1996
------------ -------------
Detail of business acquired in
purchase transaction:
Purchased In-Process Research
and Development $ 4,720,000 $ 8,300,000
Fair Value of Assets Acquired (net of
previous investment, if any) 1,216,000 3,999,000
Liabilities Assumed (677,000) (459,000)
Common Stock Issued in the Acquisition - (6,894,000)
----------- -------------
Cash Paid for the Acquisition,
net of cash acquired $ 5,259,000 $ 4,946,000
============ =============
See notes to consolidated financial statements.
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QUALITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
- ------ ---------------------
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the requirements of Form 10-Q and, therefore,
do not include all information and footnotes which would be presented were
such financial statements prepared in accordance with generally accepted
accounting principles, and should be read in conjunction with the audited
financial statements presented in the Company's Annual Report for the
fiscal year ended March 31, 1997. In the opinion of management, the
accompanying financial statements reflect all adjustments which are
necessary for a fair presentation of the results of operations for the
interim periods presented. The results of operations for such interim
periods are not necessarily indicative of results of operations to be
expected for the full year.
NOTE 2 - ACQUISITION OF MICROMED HEALTHCARE INFORMATION SYSTEMS, INC.
- ------ ------------------------------------------------------------
On May 15, 1997, the Company acquired substantially all of the assets of
MicroMed Healthcare Information Systems, Inc. ("MicroMed"), a developer and
marketer of proprietary information systems utilizing a graphical user
interface client/server platform for medical group practices. The purchase
price consists of an initial cash payment of $4.8 million paid at the
closing of the transaction and an additional payment of up to $6.0 million
due no later than June 29, 1998. The additional payment will be determined
using a formula based primarily upon Revenues and Pre-Tax Operating Income
of the MicroMed Business, each as defined in the related Asset Purchase
Agreement, for the twelve months ending March 31, 1998. Up to 15% of the
additional payment, if any, is payable in the Company's Common Stock at the
sole election of the Company with the balance of any such payment payable
in cash. As of the closing date of the transaction, MicroMed also had an
operating loan payable to the Company in the amount of $550,000. For
accounting purposes, the loan balance is considered part of the purchase
price in addition to the $4.8 million payment made at the closing. The
acquisition was treated as a purchase for financial reporting purposes. In
connection with this treatment, the Company allocated $4.7 million of the
purchase price paid at the closing of the transaction to purchased in-
process research and development which was charged against operations
during the quarter ending June 30, 1997.
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NOTE 3 - STOCK REPURCHASE PLAN
- ------ ---------------------
In February 1997, the Company's Board of Directors authorized the
repurchase on the open market of up to 10% of the Company's outstanding
Common Stock at various times through February 1998, subject to compliance
with applicable laws and regulations. The timing and amount of any
repurchase is at the discretion of the Company's management. The Company's
management could, in the exercise of its judgment, repurchase fewer shares
than authorized. During the three months ended June 30, 1997, the Company
repurchased 5,000 shares at a cost of $34,000. Since the inception of the
repurchase program through August 8, 1997, 24,300 shares have been
repurchased at a cost of $160,000.
NOTE 4 - INCOME TAXES
- ------ ------------
The provision for income taxes for the three months ended June 30, 1997
differs from the combined statutory rate primarily due to the effect of
varying state tax rates together with the impact of non-deductible
amortization of certain intangible assets acquired in the May 1996
acquisition of Clinitec International, Inc. ("Clinitec"). The MicroMed
acquisition was structured as a taxable transaction while the Clinitec
acquisition was tax-free at the acquisition date. Consequently, the
provision for income taxes for the three months ended June 30, 1996 differs
from the combined statutory rate primarily due to the $8.3 million non-
deductible charge for purchased in-process research and development
incurred in connection with the May 1996 acquisition of Clinitec.
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Item 2. Management's Discussion and Analysis of Financial Condition
- ------- -----------------------------------------------------------
and Results of Operations
-------------------------
Except for the historical information contained herein, the matters
discussed in this Quarterly Report on Form 10-Q, including discussions of
the Company's product development plans and business strategies and market
factors influencing the Company's results, are forward-looking statements
that involve certain risks and uncertainties. Actual results may differ
from those anticipated by the Company as a result of various factors, both
foreseen and unforeseen, including, but not limited to, the Company's
ability to continue to develop new products and increase systems sales in a
market characterized by rapid technological evolution, consolidation, and
competition from larger, better capitalized competitors. Many other
economic, competitive, governmental and technological factors could impact
the Company's ability to achieve its goals and interested persons are urged
to review the risks described below, as well as in the Company's other
public disclosures and filings with the Securities and Exchange Commission.
RISK FACTORS
DEPENDENCE ON PRINCIPAL PRODUCT AND NEW PRODUCT DEVELOPMENT - The Company
currently derives substantially all of its net revenues from sales of its
health care information systems and related services. The Company believes
that a primary factor in the market acceptance of its systems has been its
ability to meet the needs of users of health care information systems. The
Company's future financial performance will depend in large part on the
Company's ability to continue to meet the increasingly sophisticated needs
of its clients through the timely development and successful introduction
of new and enhanced versions of its systems and other complementary
products. The Company has historically expended a significant amount of
its net revenues on product development and believes that significant
continuing product development efforts will be required to sustain the
Company's growth.
There can be no assurance that the Company will be successful in its
product development efforts, that the market will continue to accept the
Company's existing or new products, or that products or product
enhancements will be developed in a timely manner, meet the requirements of
health care providers or achieve market acceptance. If new products or
product enhancements do not achieve market acceptance, the Company's
business, operating results and financial condition could be adversely
affected. At certain times in the past, the Company has also experienced
delays in purchases of its products by clients anticipating the launch of
new products by the Company. There can be no assurance that material order
deferrals in anticipation of new product introductions will not occur.
COMPETITION - The market for health care information systems is intensely
competitive and the Company faces significant competition from a number of
different sources. The electronic medical records market, in particular,
is subject to rapid changes in technology and the Company expects that
competition in this portion of the market will increase as new competitors
enter the marketplace. In addition, several of the Company's competitors
have significantly greater name recognition as well as substantially
greater financial, technical, product development and marketing resources
than the Company.
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The industry is highly fragmented and includes numerous competitors, none
of which the Company believes dominates the overall market for either group
practice management or electronic medical records systems. Furthermore, the
Company also competes indirectly and to varying degrees with other major
health care related companies, information management companies generally,
and other software developers which may more directly enter the markets in
which the Company competes.
There can be no assurance that future competition or new product
introductions will not have a material adverse effect on the Company's
business, financial condition and results of operations. Competitive
pressures and other factors, such as new product introductions by the
Company or its competitors, may result in price erosion that could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company believes that once a health care provider has chosen a
particular health care information system vendor, the provider will, for a
period of time, be more likely to rely on that vendor for its future
information system requirements. In addition, if the health care industry
continues to undergo further consolidation as it has recently experienced,
each sale of the Company's systems will assume even greater importance to
the Company's business, financial condition and results of operations. The
Company's inability to make initial sales of its systems to either newly
formed groups and/or health care providers that are replacing or
substantially modifying their health care information systems could have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, if new systems sales do not
materialize, maintenance service revenues can be expected to decrease over
time due to failure to capture new maintenance revenues therefrom and to
attrition of existing maintenance revenues associated with the Company's
existing clients whose systems become obsolete or are replaced by
competitor's products.
TECHNOLOGICAL CHANGE - The software market generally is characterized by
rapid technological change, changing customer needs, frequent new product
introductions and evolving industry standards. The introduction of
products incorporating new technologies and the emergence of new industry
standards could render the Company's existing products obsolete and
unmarketable. There can be no assurance that the Company will be
successful in developing and marketing new products that respond to
technological changes or evolving industry standards. New product
development depends upon significant research and development expenditures
which depend ultimately upon sales growth. Any material weakness in
revenues or research funding could impair the Company's ability to respond
to technological advances in the marketplace and remain competitive. If
the Company is unable, for technological or other reasons, to develop and
introduce new products in a timely manner in response to changing market
conditions or customer requirements, the Company's business, results of
operations and financial condition will be materially adversely affected.
9
In response to increasing market demand, the Company is currently
developing new generations of certain of its group practice management
software products that will be designed for the client/server and
Internet/intranet environments. There can be no assurance that the Company
will successfully develop these new software products or that these
products will operate successfully on the principal client/server operating
systems, which include UNIX*, Microsoft Windows**, Windows NT** and Windows
95**, or that any such development, even if successful, will be completed
concurrently with or prior to introduction by competitors of products
designed for the client/server and Internet/intranet environments. Any
such failure or delay could adversely affect the Company's competitive
position or could make the Company's current practice management product
line designed for the UNIX environment obsolete.
FLUCTUATION IN QUARTERLY OPERATING RESULTS - The Company's revenues and
operating results have in the past fluctuated, and may in the future
fluctuate, from quarter to quarter and period to period as a result of a
number of factors including, without limitation: the size and timing of
orders from clients; the length of sales cycles and installation processes;
the ability of the Company's clients to obtain financing for the purchase
of the Company's products; changes in pricing policies or price reductions
by the Company or its competitors; the timing of new product announcements
and product introductions by the Company or its competitors; the
availability and cost of supplies; the financial stability of major
clients; market acceptance of new products, applications and product
enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements and to control costs; the
Company's success in expanding its sales and marketing programs; deferrals
of client orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
economic factors.
The Company's products are generally shipped as orders are received and
accordingly, the Company has historically operated with minimal backlog.
As a result, sales in any quarter are dependent on orders booked and
shipped in that quarter and are not predictable with any degree of
certainty. Furthermore, the Company's systems can be relatively large and
expensive and individual systems sales can represent a significant portion
of the Company's revenues for a quarter such that the loss of even one such
sale can have a significant adverse impact on the Company's quarterly
profitability. Clients often defer systems purchases until the Company's
quarter end, so quarterly results generally cannot be predicted and
frequently are not known until the quarter has concluded. The Company's
initial contact with a potential customer depends in significant part on
the customer's decision to replace, or substantially modify, its existing
information system. How and when to implement, replace or substantially
modify an information system are major decisions for health care providers.
Accordingly, the sales cycle for the Company's systems can vary
significantly and typically ranges from three to 12 months from initial
contact to contract execution/shipment and the installation cycle is
typically two to four months from contract execution/shipment to completion
of installation.
* UNIX is a registered trademark of AT&T Corporation.
** Microsoft Windows, Windows NT and Windows 95 are registered
trademarks of Microsoft Corporation.
10
Because a significant percentage of the Company's expenses are relatively
fixed, a variation in the timing of systems sales and installations can
cause significant variations in operating results from quarter to quarter.
As a result, the Company believes that interim period-to-period comparisons
of its results of operations are not necessarily meaningful and should not
be relied upon as indications of future performance. Further, the Company's
historical operating results are not necessarily indicative of future
performance for any particular period.
Due to all of the foregoing factors, it is possible that in some future
quarter the Company's operating results may be below the expectations of
public market analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially adversely affected.
PROPRIETARY TECHNOLOGY - The Company is heavily dependent on the
maintenance and protection of its intellectual property and relies largely
on license agreements, confidentiality procedures and employee
nondisclosure agreements to protect its intellectual property. The
Company's software is not patented and existing copyright laws offer only
limited practical protection. There can be no assurance that the legal
protections and precautions taken by the Company will be adequate to
prevent misappropriation of the Company's technology or that competitors
will not independently develop technologies equivalent or superior to the
Company's. Further, the laws of some foreign countries do not protect the
Company's proprietary rights to as great an extent as do the laws of the
United States.
The Company does not believe that its operations or products infringe on
the intellectual property rights of others. However, there can be no
assurance that others will not assert infringement or trade secret claims
against the Company with respect to its current or future products or that
any such assertion will not require the Company to enter into a license
agreement or royalty arrangements with the party asserting the claim. As
competing health care information systems increase in complexity and
overall capabilities and the functionality of these systems further
overlap, providers of such systems may become increasingly subject to
infringement claims. Responding to and defending any such claims may
distract the attention of Company management and have a material adverse
effect on the Company's business, financial condition and results of
operations. In addition, claims may be brought against third parties from
which the Company purchases software, and such claims could adversely
affect the Company's ability to access third party software for its
systems.
CLINITEC INTERNATIONAL, INC. - A principal component of the Company's
business strategy is the May 1996 acquisition of Clinitec International,
Inc. ("Clinitec"). The Company's future financial results will depend in
part on the Company's ability to achieve market acceptance for Clinitec's
products and successfully integrate Clinitec's business with the Company's.
There can be no assurance that the Company will be able to successfully
coordinate its business activities with those of Clinitec. Furthermore,
there can be no assurance that the Company will be successful in fully
integrating Clinitec's products with those of the Company or that the
acquisition of Clinitec will not have an adverse effect upon the Company's
operating results. In addition, Clinitec was formed in January 1994 to
develop and market electronic medical records software systems. Clinitec's
proprietary software products are relatively new and Clinitec has sold only
a limited quantity of these products to date. There can be no assurance
that Clinitec's products will achieve broad market acceptance.
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MICROMED HEALTHCARE INFORMATION SYSTEMS, INC. - A principal component of
the Company's business strategy is the May 1997 acquisition of MicroMed
Healthcare Information Systems, Inc. ("MicroMed"). The Company's future
financial results will depend in part on the Company's ability to achieve
market acceptance for MicroMed's products and successfully integrate
MicroMed's business with the Company's. There can be no assurance that the
Company will be able to successfully coordinate its business activities
with those of MicroMed. Furthermore, there can be no assurance that the
Company will be successful in fully integrating MicroMed's products with
those of the Company or that the acquisition of MicroMed will not have an
adverse effect upon the Company's operating results. In addition, MicroMed
was formed in February 1993 to develop and market medical practice
management software systems. MicroMed's proprietary software products are
new and MicroMed has sold only a limited quantity of these products to
date. There can be no assurance that MicroMed's products will achieve
broad market acceptance.
ABILITY TO MANAGE GROWTH - The Company has recently experienced a period of
growth and increased personnel which has placed, and will continue to
place, a significant strain on the Company's resources. The Company
anticipates expanding its overall software development, marketing, sales,
client management and training capacity. In the event the Company is
unable to identify, hire, train and retain qualified individuals in such
capacities within a reasonable time frame, such failure could have a
material adverse effect on the Company. In addition, the Company's ability
to manage future increases, if any, in the scope of its operations or
personnel will depend on significant expansion of its research and
development, marketing and sales, management and administrative, and
financial capabilities. The failure of the Company's management to
effectively manage expansion in its business could have a material adverse
effect on the Company's business, results of operations and financial
condition.
PRODUCT LIABILITY - Certain of the Company's products provide applications
that relate to patient medical information. Any failure by the Company's
products to provide accurate and timely information could result in claims
against the Company. The Company maintains insurance to protect against
claims associated with the use of its products, but there can be no
assurance that its insurance coverage would adequately cover any claim
asserted against the Company. A successful claim brought against the
Company in excess of its insurance coverage could have a material adverse
effect on the Company's business, financial condition and results of
operations. Even unsuccessful claims could result in the Company's
expenditure of funds in litigation and management time and resources.
There can be no assurance that the Company will not be subject to product
liability claims, that such claims will not result in liability in excess
of its insurance coverage, that the Company's insurance will cover such
claims or that appropriate insurance will continue to be available to the
Company in the future at commercially reasonable rates. Such claims could
have a material adverse affect on the Company's business, financial
condition and results of operations.
12
UNCERTAINTY IN HEALTH CARE INDUSTRY; GOVERNMENT REGULATION - The health
care industry is subject to changing political, economic and regulatory
influences that may affect the procurement processes and operation of
health care facilities. During the past several years, the health care
industry has been subject to an increase in governmental regulation of,
among other things, reimbursement rates and certain capital expenditures.
Certain legislators have announced that they intend to examine proposals to
reform certain aspects of the U.S. health care system including proposals
which may increase governmental involvement in health care, lower
reimbursement rates and otherwise change the operating environment for the
Company's clients. Health care providers may react to these proposals and
the uncertainty surrounding such proposals by curtailing or deferring
investments, including those for the Company's systems and related
services. Cost-containment measures instituted by health care providers as
a result of regulatory reform or otherwise could result in greater
selectivity in the allocation of capital funds. Such selectivity could
have an adverse effect on the Company's ability to sell its systems and
related services. The Company cannot predict what impact, if any, such
proposals or health care reforms might have on its business, financial
condition and results of operations.
The Company's software may be subject to regulation by the U.S. Food and
Drug Administration (the "FDA") as a medical device. Such regulation could
require the registration of the applicable manufacturing facility and
software/hardware products, application of detailed recordkeeping and
manufacturing standards, and FDA approval or clearance prior to marketing.
An approval or clearance could create delays in marketing, and the FDA
could require supplemental filings or object to certain of these
applications.
DEPENDENCE UPON KEY PERSONNEL - The Company's future performance also
depends in significant part upon the continued service of its key technical
and senior management personnel, many of whom have been with the Company
for a significant period of time. Because the Company has a relatively
small number of employees when compared to other leading companies in the
same industry, its dependence on maintaining its employees is particularly
significant. The Company is also dependent on its ability to attract and
retain high quality personnel, particularly highly skilled software
engineers for applications development. The industry is characterized by a
high level of employee mobility and aggressive recruiting of skilled
personnel. There can be no assurance that the Company's current employees
will continue to work for the Company. Loss of services of key employees
could have a material adverse effect on the Company's business, results of
operations and financial condition. The Company does not maintain key man
life insurance on any of its employees. The Company may need to grant
additional stock options to key employees and provide other forms of
incentive compensation to attract and retain such key personnel.
GENERAL
Quality Systems, Inc. ("QSI") and its wholly-owned subsidiaries, Clinitec
and MicroMed, (all three collectively the "Company") develop and market
health care information systems that automate medical and dental group
practices, physician hospital organizations ("PHOs"), management service
organizations ("MSOs"), health maintenance organizations ("HMOs") and
community health centers. In response to the growing need for more
comprehensive, cost-effective information solutions for physician and
13
dental practice management, the Company's systems provide clients with the
ability to redesign patient care and other workflow processes, to improve
productivity and reduce information processing and administrative costs and
to provide multi-site access to patient information. The Company's
proprietary software systems include general patient information and
summary medical records, appointment scheduling, billing, insurance claims
submission and processing, managed care plan implementation and referral
management, treatment outcome studies, treatment planning, drug
formularies, patient electronic medical records, word processing and
accounting. In addition to providing fully integrated information
solutions to its clients, the Company provides comprehensive hardware and
software installation, maintenance and support services, system training
services and electronic insurance claims submission services.
The Company currently has an installed base of more than 500 operating
health care information systems serving PHOs, MSOs, HMOs, group practices,
specialty practices, dental schools and other health care organizations,
each of which consists of one to 120 physicians or dentists. The Company
believes that as health care providers are increasingly required to reduce
costs while maintaining the quality of health care, the Company will be
able to capitalize on its strategy of providing fully integrated
information systems and superior customer service.
QSI is a California corporation formed in 1974 and was founded with an
early focus on providing information systems and services primarily for
dental group practices. QSI's initial "turnkey" systems were designed to
improve productivity while reducing information processing costs and
personnel requirements. In the mid-1980's, QSI capitalized on the
opportunity presented by the increasing pressure of cost containment on
physicians and health care organizations and further expanded its
information processing systems into the broader medical market. Today, QSI
develops and provides integrated UNIX-based health care information systems
for both the medical and dental markets. These systems operate on a stand-
alone basis or in a networked environment and are expandable to accommodate
client needs.
Augmenting its practice management software, QSI added Clinitec's
electronic medical records software to its product line in 1995 and
completed its acquisition of Clinitec in May 1996. Clinitec's principal
product, NextGen*, permits scanning, annotation, retrieval and analysis of
medical records in all formats, from documents to photographs and X-rays.
NextGen has been developed using a client/server platform, a graphical user
interface for compatibility with UNIX, Microsoft Windows, Windows NT and
Windows 95 operating systems, and a relational database for flexibility in
screen customization, reporting and logic flow. With the addition of
NextGen, the Company is able to provide its clients with a comprehensive
information management solution. NextGen, in conjunction with QSI's
practice management software, was first installed at a beta site in August
1995 and is currently being installed in additional sites. The Company is
also in the process of designing an alternative client/server version of
its practice management products utilizing a graphical user interface with
the intent of enabling a more seamless integration of the QSI and NextGen
applications.
* NextGen is a registered trademark of Clinitec International, Inc.
14
Further augmenting its product line, the Company purchased substantially
all of the assets of MicroMed in May 1997. MicroMed develops proprietary
medical practice management systems that utilize a client/server platform,
a graphical user interface for compatibility with Windows 95 and Windows NT
operating systems, and a relational database that is ANSI SQL compliant in
contrast with the Company's existing practice management systems which are
primarily character based. MicroMed was formed in 1993 and, as of July
1997, MicroMed had seven installed customer sites which include a medical
center with more than 70 doctors, 20 locations and nearly 100 simultaneous
users.
15
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth for the periods indicated, the percentage of
net revenues represented by each item in the Company's consolidated
statements of operations. The consolidated statements of operations
include the operations of Clinitec from May 17, 1996, the date of
Clinitec's acquisition, through June 30, 1997, and the operations of
MicroMed from May 15, 1997, the date of MicroMed's acquisition, through
June 30, 1997.
Three Months
Ended
June 30,
-----------------
1997 1996
------- -------
Net Revenues:
Sales of computer systems,
upgrades and supplies 65.7 % 59.5 %
Maintenance and other services 34.3 40.5
------- --------
100.0 100.0
Cost of Products and Services 49.7 48.9
------- --------
Gross Profit 50.3 51.1
Selling, General and
Administrative Expenses 35.4 30.2
Research and Development Costs 11.5 9.6
Purchased In-Process Research and
Development 65.8 174.5
------- --------
Loss from Operations (62.4) (163.2)
Investment Income 3.8 8.1
Equity in Loss of Clinitec
International, Inc. - (0.7)
------- --------
Loss before Provision for
(Benefit from) Income Taxes (58.6) (155.8)
Provision for (Benefit from)
Income Taxes (20.5) 7.5
------- --------
Net Loss (38.1)% (163.3)%
======= ========
16
For the Three-Month Periods Ended June 30, 1997 and 1996.
- ---------------------------------------------------------
After recognizing a $4.7 million charge for purchased in-process research
and development in connection with the acquisition of the MicroMed
business, the Company incurred a net loss of $(2.7) million, or $(0.46) per
share, for the three months ended June 30, 1997. In comparison, after
recognizing an $8.3 million charge for purchased in-process research and
development in connection with the Clinitec acquisition, the Company
incurred a net loss of $(7.8) million, or $(1.34) per share, for the three
months ended June 30, 1996.
Net Revenues. Net revenues for the three months ended June 30, 1997
increased 50.9% to $7.2 million from $4.8 million for the three months
ended June 30, 1996. Sales of computer systems, upgrades and supplies
increased 66.5% to $4.7 million from $2.8 million while net revenues from
maintenance and other services grew 27.9% to $2.5 million from $1.9 million
during the comparable periods. The increase in net revenues from sales of
computer systems, upgrades and supplies was principally due to an increase
in such revenues for both QSI and Clinitec while the increase in
maintenance and other services net revenue resulted principally from an
increase in such revenues for QSI which has a larger client base than the
more recently formed Clinitec. The Company's quarterly results fluctuate
and there can be no assurance that similar revenue increases or revenue
levels will be achieved in future quarters.
Cost of Products and Services. Costs of products and services for the
three months ended June 30, 1997 increased 53.5% to $3.6 million from $2.3
million for the three months ended June 30, 1996 while costs of products
and services as a percentage of net revenues increased to 49.7% from 48.9%
during the comparable periods. The increase in costs of products and
services in both amount and as a percentage of net revenues during the June
30, 1997 quarter as compared to the June 30, 1996 quarter results from a
combination of the effects of: the increase in net revenues from sales of
computer systems and upgrades; increased product development, customer
service, support, and training personnel during the June 30, 1997 quarter
reflecting the Company's recent growth in annual sales volumes; and, the
impact of the acquisition of MicroMed. Without the acquisition of
MicroMed, the costs of products and services as a percentage of net
revenues would have remained relatively unchanged.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended June 30, 1997 increased
76.4% to $2.5 million from $1.4 million for the three months ended June 30,
1996 primarily as a result of: the consolidation of MicroMed's selling,
general and administrative expenses during the portion of the quarter ended
June 30, 1997 following the acquisition of the MicroMed business; the
inclusion of such Clinitec expenses for the entire quarter ended June 30,
1997 as compared to only a portion of the corresponding period ended June
30, 1996 as the Clinitec acquisition was completed in May 1996; and, an
increase in QSI's and Clinitec's selling efforts, sales personnel and
administrative infrastructure. In addition, primarily as a result of the
less mature Clinitec and MicroMed infrastructures, selling, general and
administrative expenses as a percentage of net revenues increased to 35.4%
from 30.2% for the respective periods.
17
Research and Development Costs. Research and development costs for the
three months ended June 30, 1997 increased 81.2% to $828,000 from $457,000
for the three months ended June 30, 1996. The increase is the result of
increased research and development efforts by QSI and Clinitec as well as
consolidation of MicroMed's research and development costs during the
portion of the quarter ended June 30, 1997 following the purchase of the
MicroMed business. Research and development costs as a percentage of net
revenues increased to 11.5% as compared to 9.6% for the respective periods
as a result of the increased efforts.
Purchased In-Process Research and Development. In connection with the
acquisition of MicroMed in May 1997, MicroMed's in-process research and
development for which technological feasibility had not been established
was valued in excess of $4.7 million. After allocating the purchase price
paid to identifiable tangible and certain intangible assets, the remaining
unallocated portion of $4.7 million was allocated to MicroMed's in-process
research and development. In accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed," software development costs must
be expensed until technological feasibility has been established.
Accordingly, the $4.7 million value allocated to MicroMed's purchased in-
process research and development was expensed during the quarter ended June
30, 1997. Correspondingly, Clinitec was acquired during the quarter ended
June 30, 1996, and its in-process research and development for which
technological feasibility had not been established as of the acquisition
date was valued at $8.3 million which value was accordingly charged to
operations during the June 30, 1996 quarter.
Investment Income and Equity in Loss of Clinitec International, Inc.
Investment income for the three months ended June 30, 1997 decreased 28.5%
to $276,000 from $386,000 for the three months ended June 30, 1996
primarily as a result of a decrease in average funds available for
investment during the quarter ended June 30, 1997. The decrease in
available funds is primarily the result of the payment made to acquire the
MicroMed business in May 1997. The Company acquired a 25% ownership
interest in Clinitec in May 1995 which was increased to 100% in May 1996.
During the period that the Company owned 25% of Clinitec, its investment
was accounted for under the equity method of accounting whereby the Company
recorded its proportionate share of Clinitec's losses as equity in loss of
Clinitec. Commencing in May 1996 when the Company acquired the remaining
75% of Clinitec, the Company consolidated Clinitec's results with those of
its own operations. Accordingly, the Company's equity in loss of Clinitec
was $(31,000) during the quarter ended June 30, 1996 with no corresponding
amount in the June 30, 1997 period.
Provision for (Benefit from) Income Taxes. The benefit from income taxes
for the three months ended June 30, 1997 was $(1.5) million as compared to
a provision of $358,000 for the three months ended June 30, 1996. The
benefit from income taxes for the three months ended June 30, 1997 differs
from the combined statutory rate primarily due to the effect of varying
state tax rates together with the impact of non-deductible amortization of
certain intangible assets acquired in the May 1996 acquisition of Clinitec.
18
The MicroMed acquisition was structured as a taxable transaction while the
Clinitec acquisition was tax-free at the acquisition date. Consequently,
the provision for income taxes for the three months ended June 30, 1996
differs from the combined statutory rate primarily due to the non-
deductible $8.3 million charge for purchased in-process research and
development incurred in connection with the May 1996 acquisition of
Clinitec.
LIQUIDITY AND CAPITAL RESOURCES.
- --------------------------------
Cash and cash equivalents decreased $(6.0) million for the three months
ended June 30, 1997 primarily as a result of the purchase of the MicroMed
business. Correspondingly, cash and cash equivalents decreased $(5.1)
million for the three months ended June 30, 1996 principally as a result of
the payment of the cash portion of the purchase price for the remaining 75%
ownership interest in Clinitec in May 1996.
Net cash used in operating activities for the three months ended June 30,
1997 was $(266,000) consisting primarily of the Company's $(2.7) million
net loss adjusted for the principal non-cash operating expenses of
depreciation, amortization and the $4.7 million charge for the MicroMed
purchased in-process research and development, plus an increase in other
current liabilities, offset by the deferred tax benefit from the charge for
purchased in-process research and development and an increase in accounts
receivable. The increase in accounts receivable during the June 30, 1997
quarter resulted primarily from increased sales as compared to the three
months ended March 31, 1997 and the timing of such sales during the
quarter. Net cash provided by operating activities for the three months
ended June 30, 1996 was $89,000 consisting primarily of the Company's
$(7.8) million net loss adjusted for the principal non-cash operating
expenses of depreciation, amortization and the $8.3 million charge for the
Clinitec purchased in-process research and development, plus the effects of
a decrease in inventories and an increase in income taxes payable offset by
an increase in accounts receivable and a decrease in accounts payable.
Net cash used in investing activities for the three months ended June 30,
1997 was $(5.7) million consisting principally of $5.3 million, including a
$550,000 operating loan made by QSI to MicroMed prior to the acquisition
date, used to purchase the MicroMed business, plus additions to equipment
and improvements and capitalized software. Net cash used in investing
activities for the three months ended June 30, 1996 was $(5.2) million
consisting principally of the payment of the $4.9 million cash portion of
the May 1996 purchase price for the remaining 75% ownership interest in
Clinitec, related legal costs of the acquisition, and additions to
equipment and improvements and capitalized software.
Net cash used in financing activities for the three months ended June 30,
1997 was $(28,000) consisting of the purchase of 5,000 shares of the
Company's Common Stock offset by proceeds from the exercise of stock
options. Net cash provided by (used in) financing activities was
negligible for the three months ended June 30, 1996.
19
In February 1997, the Company's Board of Directors authorized the
repurchase on the open market of up to 10% of the Company's outstanding
Common Stock at various times through February 1998, subject to compliance
with applicable laws and regulations. The timing and amount of any
repurchase is at the discretion of the Company's management. The Company's
management could, in the exercise of its judgment, repurchase fewer shares
than authorized. During the three months ended June 30, 1997, the Company
repurchased 5,000 shares at a cost of $34,000. Since the inception of the
repurchase program through August 8, 1997, 24,300 shares have been
repurchased at a cost of $160,000.
At June 30, 1997, the Company had cash and cash equivalents of $15.9
million and short-term investments of $910,000. Short-term investments
include a $668,000 investment in a fund which trades in special situation
securities. There can be no assurance that the markets for these
securities will not change, causing a loss of principal.
In March 1996, QSI raised $20.2 million to be used for general corporate
purposes, including the financing of product sales growth, development of
new products, working capital requirements, an increase in its ownership
interest in Clinitec (which was completed in May 1996), and the possible
acquisitions of complementary businesses and technologies. The Company
continues to evaluate potential investment opportunities and in May 1997
acquired substantially all of the assets of MicroMed for an initial cash
payment of $4.8 million in addition to a previously advanced $550,000
operating loan plus a potential future additional payment based upon
operating results of the MicroMed business for the twelve months ending
March 31, 1998. The additional payment, if any, ranges up to $6.0 million,
up to 15% of which is payable at the option of QSI in Common Stock, and is
due on or before June 29, 1998. Pursuant to an independent valuation of
the assets acquired, it is anticipated that a significant portion of any
future additional payment will be charged to operations as additional
purchased in-process research and development during the quarter ending
March 31, 1998.
Except for the acquisition of MicroMed and the Company's intention to
expend funds on capitalized software in connection with complementary
products to its existing product line (including a $215,000 payment
anticipated to be made during the quarter ending September 30, 1997 to
acquire rights to certain third party software) and alternative versions of
certain of its products for the client/server environment to take advantage
of more powerful technologies and to enable a more seamless integration of
the Company's products, the Company has no other significant capital
commitments and currently anticipates that additions to equipment and
improvements for fiscal 1998 will be comparable to fiscal 1997.
The Company believes that its cash and cash equivalents and short-term
investments on hand at June 30, 1997, together with the cash flows from
operations, if any, will be sufficient to meet its working capital and
capital expenditure requirements for the next year.
20
PART II. OTHER INFORMATION
- -------- -----------------
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits:
---------
The Exhibits listed on the accompanying Index to Exhibits
on page 22 are filed as part of this report.
(b) Reports on Form 8-K:
--------------------
The Registrant filed a Current Report on Form 8-K
dated May 15, 1997 reporting the acquisition of substantially
all of the assets of MicroMed Healthcare Information Systems, Inc.
No financial statements or pro forma information in connection
with the acquisition were required to be filed, and accordingly,
no such information was filed.
21
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
QUALITY SYSTEMS, INC.
Date August 11, 1997 By /s/ Sheldon Razin
--------------- ----------------------------------
Sheldon Razin
President and Chairman
of the Board of Directors;
Principal Executive Officer
Date August 11, 1997 By /s/ Robert G. McGraw
--------------- ----------------------------------
Robert G. McGraw
Chief Financial Officer;
Principal Accounting Officer
22
INDEX TO EXHIBITS
Sequential
Page
Exhibit No.
------- ----------
11.0 Earnings per share computation, is filed herewith 23
27.0 Financial Data Schedule, is filed herewith. 24
23
EXHIBIT 11.0
------------
The net loss per share for the three months ended June 30, 1997 was
computed using the weighted average number of shares actually outstanding
during the periods of 5,998,000 and 5,807,000, respectively and any common
share equivalents were excluded because their impact would have been anti-
dilutive.